Learning from Silver&rsquo;s Collapse

Silver’s euphoric run higher and the severe collapse that followed can teach some important lessons for the future, explains market technician Corey Rosenbloom.

We’re going to talk about silver and what we can learn about that euphoria and drop off after. Corey, talk about that silver market; what lessons can be learned for traders?

Let’s start at the beginning. Let’s start when silver was about $20 per ounce, before the euphoric run-up in 2010 and into 2011.

What happened there, it was a dull market; say we were in an accumulation phase. Then the market began to break higher really at the confluence of QE2. That came in August/September 2010 when a lot of markets broke to the upside, commodities in particular.

So, that rallied very quickly to $30 per ounce, had resistance there, and actually came down into, I think it was, December or January.

Well, from that price, it went on a euphoric—really a monumental rally—from the $30 level to $50 per ounce, which tested the 1980’s high. That happened really within the course of a month or so. It was very euphoric and very—I would say in terms of technical analysis—unique and violent.

So, the lessons from that. A lot of traders have trouble trading these moves because they cannot anticipate how far the market will move.

In the market, it’s just a natural thing. Most traders, as they become professionals, they tend to become more fade traders. So, when the market is going higher, they say, “Oh, it cannot continue.It must go down.” So they try to short the market.

Well, that doesn’t always work, and the concept of feedback loops is what perpetuates these moves. So, as a trader, it is best to look at markets that are more stable, not the ones that are euphoric because risk increases exponentially.

We looked at metrics of volume; it was exploding. We looked at standard deviation metrics; the market was moving (at the euphoric time) three and four standard deviations from the mean. That’s significant. That’s risk. The average true range was going to new highs as silver was increasing exponentially.

Risk is higher, therefore, traders should adapt to it. Generally, that means reducing position size, holding positions longer, widening stops, and if the volatility is too high (if it is a new trader), go to some other market.

There’s no requirement that makes you participate in these kinds of moves.

NEXT: Know the Warning Signs to Watch for on the Charts

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So, when you see that euphoria, traders then essentially should maybe step out or at least reduce size significantly.

Looking back on that, was there anything on the chart that said, “This is going to drop off. We are seeing or are close to a top here.”

Hindsight is always easier, of course, to see on that chart, but anything looking back that we all should have seen?

Well, almost it’s an instability. So, these things happen. Silver…this pattern has happened in stocks, it’s happened in other commodities, it’s actually happened in 1980 in silver itself.

So, we look for a lot of things. We look at arc pattern trend lines that become euphoric. So picture an arc as it begins to rise on the chart. They start small toward the bottom, arch higher gently, and then come to almost a 90-degree period at the top.

Well, obviously, price cannot bend backwards on itself, so the patterns we look for are exhaustion patterns on those kinds of maneuvers is not standard trend lines. Those do not work. Horizontal trend lines do not work. One must connect trend lines with price lows in an arc formation.

Once a price breaks through, say, a vertical arc, that’s an enormous signal. There are also things that were there too. There were reversal candles, very wide, very high-wick, very large-range reversal candles at the highs at $50.

Plus, there was a resistance high of $50 per ounce from 1980 that just was a reference level. But, yes, it’s just the euphoric conditions, almost the climactic pattern, and the breaking of that arc trend line signals a lot of risk is in place.

Then we began to break hourly moving averages, daily moving averages, and that’s when the decline exacerbated.

So, obviously trying to pick tops in that type of market is extremely dangerous because really you don’t know when it’s going to end.

Well, trying to pick tops or trying to continue in that move, because it’s a risk for both traders. That’s the danger of it. People think, “Oh, I’m going to capture this and continue riding higher.”

It’s like musical chairs. It can end at any moment, and at the same time, people were trying to short silver at $43, $44, $45, $46, and eventually it hit $50 and then collapsed very quickly, and it actually made one more—we call a “last-gasp” high—made one more move to a new high that tricked a lot of people who had just gotten short, and then it collapsed.

So, the risk is high. There’s plenty of opportunity elsewhere in these kinds of environments.